Exercises on Options

1. The price that the buyer of a call option pays to acquire the option is called the A) strike price B) exercise price C) execution price D) acquisition price E) premium Answer: E Difficulty: Easy

2. The price that the writer of a call option receives to sell the option is called the A) strike price B) exercise price C) execution price D) acquisition price E) premium Answer: E Difficulty: Easy

3. The price that the buyer of a put option pays to acquire the option is called the A) strike price B) exercise price C) execution price D) acquisition price E) premium Answer: E Difficulty: Easy

4. The price that the writer of a put option receives to sell the option is called the A) premium B) exercise price C) execution price D) acquisition price E) strike price Answer: A Difficulty: Easy

5. The price that the buyer of a call option pays for the underlying asset if she executes her option is called the A) strike price B) exercise price C) execution price D) A or C E) A or B Answer: E Difficulty: Easy

6. The price that the writer of a call option receives for the underlying asset if the buyer executes her option is called the A) strike price B) exercise price C) execution price D) A or B E) A or C Answer: D Difficulty: Easy

7. The price that the buyer of a put option receives for the underlying asset if she executes her option is called the A) strike price B) exercise price C) execution price D) A or C E) A or B Answer: E Difficulty: Easy

8. The price that the writer of a put option receives for the underlying asset if the option is exercised is called the A) strike price B) exercise price C) execution price D) A or B E) none of the above Answer: E Difficulty: Easy

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9. An American call option allows the buyer to A) sell the underlying asset at the exercise price on or before the expiration date. B) buy the underlying asset at the exercise price on or before the expiration date. C) sell the option in the open market prior to expiration. D) A and C. E) B and C. Answer: E Difficulty: Easy Rationale: An American call option may be exercised (allowing the holder to buy the underlying asset) on or before expiration; the option contract also may be sold prior to expiration.

10. A European call option allows the buyer to A) sell the underlying asset at the exercise price on the expiration date. B) buy the underlying asset at the exercise price on or before the expiration date. C) sell the option in the open market prior to expiration. D) buy the underlying asset at the exercise price on the expiration date. E) C and D. Answer: E Difficulty: Easy Rationale: A European call option may be exercised (allowing the holder to buy the underlying asset) on the expiration date; the option contract also may be sold prior to expiration.

11. An American put option allows the holder to A) buy the underlying asset at the striking price on or before the expiration date. B) sell the underlying asset at the striking price on or before the expiration date. C) potentially benefit from a stock price decrease with less risk than short selling the stock. D) B and C. E) A and C. Answer: D Difficulty: Easy Rationale: An American put option allows the buyer to sell the underlying asset at the striking price on or before the expiration date. The put option also allows the investor to benefit from an expected stock price decrease while risking only the amount invested in the contract.

12. A European put option allows the holder to A) buy the underlying asset at the striking price on or before the expiration date. B) sell the underlying asset at the striking price on or before the expiration date. C) potentially benefit from a stock price decrease with less risk than short selling the stock. D) sell the underlying asset at the striking price on the expiration date. E) C and D. Answer: E Difficulty: Easy Rationale: A European put option allows the buyer to sell the underlying asset at the striking price on or before the expiration date. The put option also allows the investor to benefit from an expected stock price decrease while risking only the amount invested in the contract.

13. An American put option can be exercised A) any time on or before the expiration date. B) only on the expiration date. C) any time in the indefinite future. D) only after dividends are paid. E) none of the above. Answer: A Difficulty: Easy Rationale: American options can be exercised on or before expiration date.

14. An American call option can be exercised A) any time on or before the expiration date. B) only on the expiration date. C) any time in the indefinite future. D) only after dividends are paid. E) none of the above. Answer: A Difficulty: Easy Rationale: American options can be exercised on or before expiration date.

15. A European call option can be exercised A) any time in the future. B) only on the expiration date. C) if the price of the underlying asset declines below the exercise price. D) immediately after dividends are paid. E) none of the above. Answer: B Difficulty: Easy Rationale: European options can be exercised at expiration only.

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16. A European put option can be exercised A) any time in the future. B) only on the expiration date. C) if the price of the underlying asset declines below the exercise price. D) immediately after dividends are paid. E) none of the above. Answer: B Difficulty: Easy Rationale: European options can be exercised at expiration only.

17. The current market price of a share of AT&T stock is $50. If a call option on this stock has a strike price of $45, the call A) is out of the money. B) is in the money. C) sells for a higher price than if the market price of AT&T stock is $40. D) A and C. E) B and C. Answer: E Difficulty: Easy Rationale: If the striking price on a call option is less than the market price, the option is in the money and sells for more than an out of the money option.

18. The current market price of a share of Boeing stock is $75. If a call option on this stock has a strike price of $70, the call A) is out of the money. B) is in the money. C) sells for a higher price than if the market price of Boeing stock is $70. D) A and C. E) B and C. Answer: E Difficulty: Easy Rationale: If the striking price on a call option is less than the market price, the option is in the money and sells for more than an at the money option.

19. The current market price of a share of CSCO stock is $22. If a call option on this stock has a strike price of $20, the call A) is out of the money. B) is in the money. C) sells for a higher price than if the market price of CSCO stock is $21. D) A and C. E) B and C. Answer: E Difficulty: Easy Rationale: If the striking price on a call option is less than the market price, the option is in the money and sells for more than a less in the money option.

20. The current market price of a share of Disney stock is $30. If a call option on this stock has a strike price of $35, the call A) is out of the money. B) is in the money. C) can be exercised profitably. D) A and C. E) B and C. Answer: A Difficulty: Easy Rationale: If the striking price on a call option is more than the market price, the option is out of the money and cannot be exercised profitably.

21. The current market price of a share of CAT stock is $76. If a call option on this stock has a strike price of $76, the call A) is out of the money. B) is in the money. C) is at the money. D) A and C. E) B and C. Answer: C Difficulty: Easy Rationale: If the striking price on a call option is equal to the market price, the option is at the money.

22. A put option on a stock is said to be out of the money if A) the exercise price is higher than the stock price. B) the exercise price is less than the stock price. C) the exercise price is equal to the stock price. D) the price of the put is higher than the price of the call. E) the price of the call is higher than the price of the put. Answer: B Difficulty: Easy Rationale: An out of the money put option gives the owner the right to sell the shares for less than market price.

23. A put option on a stock is said to be in the money if A) the exercise price is higher than the stock price. B) the exercise price is less than the stock price.

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C) the exercise price is equal to the stock price. D) the price of the put is higher than the price of the call. E) the price of the call is higher than the price of the put. Answer: A Difficulty: Easy Rationale: An in the money put option gives the owner the right to sell the shares for more than market price.

24. A put option on a stock is said to be at the money if A) the exercise price is higher than the stock price. B) the exercise price is less than the stock price. C) the exercise price is equal to the stock price. D) the price of the put is higher than the price of the call. E) the price of the call is higher than the price of the put. Answer: C Difficulty: Easy

25. A call option on a stock is said to be out of the money if A) the exercise price is higher than the stock price. B) the exercise price is less than the stock price. C) the exercise price is equal to the stock price. D) the price of the put is higher than the price of the call. E) the price of the call is higher than the price of the put. Answer: A Difficulty: Easy Rationale: An out of the money call option gives the owner the right to buy the shares for more than market price.

26. A call option on a stock is said to be in the money if A) the exercise price is higher than the stock price. B) the exercise price is less than the stock price. C) the exercise price is equal to the stock price. D) the price of the put is higher than the price of the call. E) the price of the call is higher than the price of the put. Answer: B Difficulty: Easy Rationale: An in the money call option gives the owner the right to buy the shares for less than market price.

27. A call option on a stock is said to be at the money if A) the exercise price is higher than the stock price. B) the exercise price is less than the stock price. C) the exercise price is equal to the stock price. D) the price of the put is higher than the price of the call. E) the price of the call is higher than the price of the put. Answer: C Difficulty: Easy

28. The current market price of a share of AT&T stock is $50. If a put option on this stock has a strike price of $45, the put A) is out of the money. B) is in the money. C) sells for a lower price than if the market price of AT&T stock is $40. D) A and C. E) B and C. Answer: D Difficulty: Easy Rationale: If the striking price on a put option is more than the market price, the option is out of the money and sells for less than an in the money option.

29. The current market price of a share of Boeing stock is $75. If a put option on this stock has a strike price of $70, the put A) is out of the money. B) is in the money. C) sells for a higher price than if the market price of Boeing stock is $70. D) A and C. E) B and C. Answer: A Difficulty: Easy Rationale: If the striking price on a put option is more than the market price, the option is out of the money and sells for less than an at the money option.

30. The current market price of a share of CSCO stock is $22. If a put option on this stock has a strike price of $20, the put A) is out of the money. B) is in the money. C) sells for a higher price than if the strike price of the put option was $25. D) A and C. E) B and C. Answer: D Difficulty: Easy Rationale: If the striking price on a put option is less than the market price, the option is out of the money and sells for less than an in the money option.

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31. The current market price of a share of Disney stock is $30. If a put option on this stock has a strike price of $35, the put A) is out of the money. B) is in the money. C) can be exercised profitably. D) A and C. E) B and C. Answer: A Difficulty: Easy Rationale: If the striking price on a put option is less than the market price, the option is out of the money.

32. The current market price of a share of CAT stock is $76. If a put option on this stock has a strike price of $80, the put A) is out of the money. B) is in the money. C) can be exercised profitably. D) A and C. E) B and C. Answer: E Difficulty: Easy Rationale: If the striking price on a put option is less than the market price, the option is in the money and can be profitably exercised.

33. The intrinsic value of an in-of-the-money call option is equal to A) the call premium. B) zero. C) the stock price minus the exercise price. D) the striking price. E) none of the above. Answer: C Difficulty: Easy Rationale: The fact that the owner of the option can buy the stock at a price less than the market price gives the contract a positive intrinsic value.

34.You write one AT&T February 50 put for a premium of $5. Ignoring transactions costs, what is the breakeven price of this position? A) $50 B) $55 C) $45 D) $40 E) none of the above Answer: C Difficulty: Easy Rationale: +$50 - $5 = $45.

35. You purchase one IBM 70 call option for a premium of $6. Ignoring transaction costs, the break-even price of the position is A) $98 B) $64 C) $76 D) $70 E) none of the above Answer: C Difficulty: Easy Rationale: +70 + $6 = $76.

36. The following price quotations on IBM were taken from the Wall Street Journal.

The premium on one IBM February 90 call contract is A) $4.1250 B) $418.00 C) $412.50 D) $158.00 E) none of the above Answer: C Difficulty: Moderate Rationale: 4 1/8 = $4.125 X 100 = $412.50. Price quotations are per share; however, option contracts are standardized for 100 shares of the underlying stock; thus, the quoted premiums must be multiplied by 100.

38. You purchased a call option for $3.45 seventeen days ago. The call has a strike price of $45 and the stock is now trading for $51. If you exercise the call today, what will be your holding period return? If you do not exercise the call today and it expires, what will be your holding period return? A) 173.9%, -100% B) 73.9%, -100%

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C) 57.5%, -173.9% D) 73.9%, -57.5% E) 100%, -100%

Answer: B Difficulty: Easy Rationale: If the call is exercised the gross profit is $51-45=$6. The net profit is $6-3.45=$2.55. The holding period return is $2.55/$3.45=.739 (73.9%). If the call is not exercised, there is no gross profit and the investor loses the full amount of the premium. The return is ($0-3.45)/$3.45=-1.00 (-100%).

39. An option with an exercise price equal to the underlying asset's price is A) worthless. B) in the money. C) at the money. D) out of the money. E) theoretically impossible. Answer: C Difficulty: Easy Rationale: This is the definition of “at the money.” The option has a market value and may increase in value if there are favorable price movements in the underlying asset before the maturity date.

40. To the option holder, put options are worth ______ when the exercise price is higher; call options are worth ______ when the exercise price is higher. A) more; more B) more; less C) less; more D) less; less E) It doesn't matter--they are too risky to be included in a reasonable person's portfolio. Answer: B Difficulty: Easy Rationale: The holder of the put would prefer to sell the asset to the writer at a higher exercise price. The holder of the call would prefer to buy the asset from the writer at a lower exercise price

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